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Asia-PacificDecember 3 2012

Merchant traders adapt to new financial landscape

Despite well-publicised retrenchment in commodities finance by some European banks, merchant trading companies are still able to find sources of funding expand their business lines.
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The potential impact of Basel III on trade finance has been well documented. Trade letters of credit, as off-balance-sheet items, will be converted into credit items for the purpose of calculating the bank’s capital requirements. The conversion rate will be 100%, so the bank will need to hold capital against the full value of trade finance, even though much of it is secured against commodities or transportation.

This could have particular implications for the merchant trading companies whose business is built on their middle-man status between the producers and consumers of natural resources. And with the vast majority of commodity transactions carried out in dollars, eurozone banks that were leading participants in the market face difficulties maintaining their financing volumes.

A new squeeze

Jerome Schurink, chief financial officer of Swiss-based oil and energy trader Gunvor Group, says about 80% of the firm’s funding needs are for trade finance secured against vessels or stored commodities, with an average duration of about 30 days. The company has added medium- and long-term financing over the past four or five years, with an ongoing syndicated loan with one- and three-year tranches, now totalling $2bn. This medium-term financing is used for storage, margin calls and pre-financing of production, but not for buying large production, storage or transportation assets, which are funded by specific project finance deals.

“Over the past two years, there has been some pressure on the pricing rather than the availability of finance, but that is an increase from very low to slightly higher margins, that are still within the bounds of what is acceptable to us,” says Mr Schurink.

Jonathan Drake, chief operating officer of small Singaporean trader RCMA, believes the merchant trading industry is treading down the same path as the banking sector pre-crisis. There is still room for niche players, while the larger firms diversify into new products and new activities such as production, refining and distribution.

We have seen a lot of traction from investors looking into this asset class, but it is early days

Christophe Salmon

“The mid-sized players could be squeezed, or move too quickly with investments that suffer in a downturn – we have already seen some accidents among Brazilian sugar traders,” he says.

The largest commodities traders have certainly been expanding. Cargill, the agricultural trading giant, stepped up metals trading in 2010. Glencore, already a leader in hydrocarbons and metals, is currently seeking to buy Canadian grain handler Viterra to grow its agricultural commodities business, in addition to its bid for mining giant Xstrata. Mercuria, one of the largest Swiss-based energy traders, hired a metals trading team from Goldman Sachs and Roger Jones, formerly Barclays head of commodities, to lead a push into non-energy commodities this year. And Gunvor, which originally grew out of trading products from Russia’s oil and gas industry, is at the early stages of an expansion into metals as well.

New traders, new banks

Even so, there is no shortage of new entrants looking for market share. Singaporean logistics firm CWT acquired London Metal Exchange (LME) member LN Metals in September 2012. Rubber trader RCMA, which was taken over in 2010 by former Barclays head of soft commodities Chris Pardey and two colleagues from his days at Cargill, expanded into coal and coffee in 2011, and hired Mr Drake, Cargill’s former head of sugar, to become chief operating officer and lead RCMA’s own drive into sugar in May 2012.

Mr Drake says RCMA uses some of the same banks as the larger or publicly quoted companies, but a smaller trader is not provided with general working capital. Instead, credit lines are tied to specific product trading, so diversifying the business can be more of a challenge.

When RCMA chose to move into sugar, the firm’s existing pool of banks wanted to see detailed business and risk plans, an experienced team in charge of the new product, and a full potential client list. After that, the decision was put to bank credit committees, typically with a six-week approval process with a further month for documentation. The whole process of securing bank lines could require up to $50,000 of the partners’ own equity to launch. But the effort paid off, with three new names joining some of RCMA’s existing facility banks to fund the sugar business.

“We have all heard about the implications of Basel III, and we did fear in March or April that credit would dry up for smaller traders. But I think that has been offset by the political pressure on banks to seek out real economy flows to finance. In the end, about a dozen banks wanted discussions with us, and we did not need funding from all of them,” says Mr Drake.

His experience is shared by the largest traders, who are finding less capital-constrained banks from emerging markets showing increased interested in commodities finance. According to Christophe Salmon, chief financial officer for Europe, Middle East and Africa at Dutch-headquartered energy and metals trader Trafigura, the larger local banks in emerging markets such as Africa, the Gulf states, Latin America and Asia have shown appetite for supporting growth in their regions. Many are either large producers, or fast-growing consumers of commodities, or both. Since these banks have less experience of structuring suitable credit facilities, Trafigura works with them, in full co-operation with its traditional European commodities finance banks.

While we have been sheltered from deleveraging in the banking sector so far, we are a partnership, so we take the long-term view

Pierre Lorinet

“The original motivation of the new players is to support their regional or domestic economy, so naturally these financial partners would prefer to finance working capital flows and fixed assets in their home markets. We have a very diversified and local activity in these regions, including storage and distribution, so de facto we could be seen as a local client even though we have a global presence. We have more than 100 banks in our pool, both global and local, a number which has more than doubled since 2007,” says Mr Salmon.

Go east

Traders say Chinese banks have become especially active replacing those who depart both from short-term trade finance, and as participants in loan syndicates. The rise of China as the marginal buyer dictating price movements in many commodities has prompted speculation that the whole industry might shift from its traditional centre of gravity in Switzerland to Asian trading centres.

The decision by Trafigura to move its commodity trading operations from Geneva to Singapore in February 2012 was widely interpreted as a sign of that shift, but chief financial officer Pierre Lorinet explains that the reasons behind the move were more administrative. The trading operations had previously sat at the holding company level, with four subsidiary operating companies running other parts of the business. To standardise the structure, the firm decided to turn the trading desk into a fifth operating company, and made use of its pre-existing licence in Singapore to save on paperwork.

“We will still have trading in Geneva for the European market, but this will now be a branch of the Singapore company, instead of part of the Dutch holding company,” says Mr Lorinet.

Brazilian miner Vale moved some of its iron ore trading to Singapore, and Mr Drake says many global banks are moving senior trade finance staff there as well. The problem is that futures trading remains concentrated in London and the US, creating operational challenges for merchants’ hedging activities.

“Of course, the Singapore Exchange would be delighted if futures markets moved to Asia, but in practice Dubai may be better placed from the point of view of serving all the different timezones,” says Mr Drake.

Capital markets route

A further obvious route for the largest merchant traders to diversify funding is a move onto the capital markets. Glencore and Trafigura have both previously issued Eurobonds, and in May 2012, Trafigura reactivated its trade receivables securitisation programme, with a $430m three-year deal that was its first since 2007.

“While we have been sheltered from deleveraging in the banking sector so far, we are a partnership, so we take the long-term view. We will benefit from broadening the number of participants who can come and inject liquidity into the sector. It has until today been very much a banking business, so we are looking to make it a standardised asset class that can draw institutional investors. The banks need that also, as they are adapting from a buy-and-hold strategy in this sector, toward an originate-to-distribute model,” says Mr Lorinet.

Mr Schurink says Gunvor has also begun to consider a bond issue, and might make a move during the next two years. “We have reached a stage of maturity of our business where a bond issue could be our next move; we are looking with a number of banks at what they can offer us, and it could be with a much longer tenor of up to 10 years,” he says.

A few merchant traders have also diversified into asset management, which can provide a further source of alternative funding. Cargill owns Black River Asset Management, while Trafigura owns Galena Asset Management. Trafigura announced in May 2012 that Galena had hired a team from Bank of America-Merrill Lynch to create a fund focused on sourcing commodity trade finance from institutional investors such as pension funds, insurers and family offices.

“We have seen a lot of traction from investors looking into this asset class, but it is early days. There will need to be plenty of investor education to help them understand the risk management of our commodity trade flows,” says Mr Salmon.

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